Global financial markets have generally been characterised
by a spate of mood swings in recent weeks although the
generally direction for most markets has been lower. The
formation of the ‘pro-austerity’ government in Greece provided
some relief for markets but this was soon diminished by
Spanish 10-year bond yields edging above 7 per cent, a level
that triggered the bailout of other Euro-zone economies. More
recently, the European Summit provided markets with a
positive surprise – that the Summit actually decided
something – which saw an increase in risk appetite and
concomitant market reaction. While the European Summit did
not find agreement on the long-term details, relief was offered
to Spain and Italy with direct bank funding from the ESM. This
is a positive move and should by the EU a little more time.

Economic conditions outside the Euro-zone appear to have
weakened, as the spill over effect from financial market
volatility on sentiment as well as reduced European imports
takes hold. Economic data coming out of the US – which had
been a beacon of hope through early 2012 – has generally
disappointed. Employment growth has slowed and
households appear rattled as income growth has not kept
pace with prices while wealth levels are impacted by weaker
equity markets. Similarly, industrial activity appears to have
slowed in recent months. In China, the recent set of partial
indicators point to an economy that has continued to soften.
Recent PMI and industrial production growth readings have
weakened and forward orders suggest a further softening in
the coming months.

With global trade also easing, the outlook for a number of
emerging market economies has weakened. In all, these
recent developments have led us to revise down our global
GDP growth forecasts to 3.2 per cent in 2012, with downward
revisions to growth in the US, Japan, Euro-zone, Asian Tigers
and India. There are considerable downside risks to our view,
however, provided that politicians commit to avoiding the
worst (such as a Euro-zone collapse or excessive fiscal
austerity in the US), the outlook for growth should improve
next year – but with lots of uncertainty and near-term market
volatility on the way.

With markets very much uncertain about the prospects of a
resolution of the Euro-zone debt crisis, risk appetite remains
relatively subdued. In essence, this generally implies that
commodity prices have weakened considerably over recent
weeks. While price movements have varied by commodity;
prices of commodities have generally softened over recent
months. Similarly, agricultural commodities are broadly lower
as the onset of risk aversion has been met with increased
volumes in some markets, thereby weakening commodities
not facing a near-term supply squeeze. At the same time,
buyers in physical markets of some commodities are
becoming increasingly cautious when faced with a more
uncertain macroeconomic environment.

For the farm sector, conditions have undoubtedly eased over
the past couple of months. Crop expectations have generally
been revised lower while weaker global prices are likely to be
impacting margins. A softening in conditions was to be
expected given that record high global prices could not last
forever while yields would eventually need to revert to more
normal levels. Nonetheless, the outlook for the farm sector as
a whole remains solid and it appears gains made over the
past two years are likely to be consolidated. ABARES
forecasts, if realised, would confirm this. At $47 billion,
ABARES recent forecast for the Australian gross value of
farm production in 2012-13 would indicate a sector still in
good health while forecasts of net farm incomes are still
expected to come in at more than 80 per cent higher than
2009-10 levels.

Currency Movements

The AUD remains beholden to the ongoing Euro-zone saga,
with relatively large swings on the back of alternating
sentiment. This pattern should continue over the near term as
any real resolution to structural problems underlying the
current crisis appear unlikely any time soon. As such, our
near term AUD/USD range is unusually wide – between
0.9850 and 1.0250, depending on news flow. Interestingly,
over recent weeks, the global commodity market has been
reflecting a weaker economic growth environment yet the
AUD has been quite slow to react. This divergence has been
in place for some time and largely reflects solid demand for
AAA assets. In a risky world where real rates being zero or
negative is becoming the norm, Australian Commonwealth
Government Bonds appear quite attractive, even at record
low yields. This has clearly helped. Having said that,
divergence in direction still appears unusual and something
has to give, hence our unusually wide near-term trading
range.

NAB Rural Commodity Index

Global agricultural commodity prices continued to ease
through May with the NAB Rural Commodity Index falling 2.4
per cent in the month in AUD terms. Given the depreciation of
the AUD/USD in the month, the fall in USD was more
pronounced, with the index falling just 5.5 per cent in USD
through the month. Driving the monthly result were prices falls
across the board, with falls recorded in prices of beef, lamb,
diary, cotton, wool and sugar. Grains prices, on the other
hand, managed to lift through the month driven by concerns
surrounding dryness in the US corn and soybean belt. In
AUD, terms, the index is now consistent with levels seen in
mid 2010, just prior to the run up in global food prices. Despite
recent weakness, the index still sits above its decade-long
average. Looking ahead, we anticipate that prices have likely
bottomed out and we should see the commodity index
strengthen through the second half of 2012, although some
downside risk is evident given macroeconomic events.

NAB Farm Input Indices

Fertiliser prices continued to recover from recent lows in May
with the NAB Weighted Fertiliser Index increasing 6.7 per cent
in the month. Driving the monthly result were price rises for
Diammonium Phosphate (up 7.1 per cent) and natural gas
(up 25.7 per cent). Urea prices, on the other hand, fell 4.3 per cent, unwinding some of the gains recorded in April. Looking
ahead, we expect global fertiliser prices to ease a little as
demand for urea slows now that the US spring planting
program is over. Attention is now turning to the South
American planting program and this should help moderate
any further falls in prices. Working against this, natural gas
prices are expected to continue to rise as the glut that has
been built up in the United States is gradually absorbed while
production begins to slow. In contrast to fertiliser prices, fuel
prices were down in May, with the fuel price index falling 3.1
per cent. Given the recent weakening in global oil prices, fuel
prices are set to fall further in the coming months, although
the fall in global prices is likely to be tempered by a decline in
the AUD.

NAB Weighted Feed Grains Price

Reflecting movements in global grains markets, Australian
feed prices lifted in May, with the NAB Weighted Feed Grains
price lifting 4.5 per cent in the month, hitting its highest level
since November last year. Driving the monthly result were
price rises for barley (up 6.3 per cent), triticale (up 5.9 per
cent), feed wheat (up 5.7 per cent) and oats (up 2.6 per cent).
In contrast, sorghum prices were flat while maize prices were
marginally lower (down 0.7 per cent). Looking ahead, prices
are likely to continue firming given the slightly weaker winter
crop outlook while the intense heat hitting the US corn and
soybean crops should help drive some export demand for
Australian feed grains.